Getting a read on Bernanke

Commentary: Volatility index drops with appointment

By

MichaelBenhamou

Editor's note: This is an update to fix a typographical error. Michael Benhamou is Managing Partner, Louis Capital Markets, LP.

NEW YORK (MarketWatch) -- Monday's announcement of Ben Bernanke's nomination to replace Alan Greenspan (especially in terms of timing) created a large reversal in the Chicago Board Option Exchange's SPX volatility index.

The VIX
VIX, -2.53%
reflects a market estimate of future volatility based on the weight estimate of implied volatility for a wide range of strikes.

It is one of the best indicators for market direction on the equity world. When VIX is high, market sentiment is bearish, on the opposite when VIX is low market sentiment is bullish (i.e. contrarians player sell stock when VIX is too low and vice-versa).

The Bernanke appointment came at the right time -- following a three-month decline in major indices and overall lackluster year for the U.S. stock market. (S&P 500
SPX, +0.32%
down 1.5%, Dow Jones
DJIA, +0.23%
down 4.16% and Nasdaq
$COMPQ
down 3.37%).

When looking at Bernanke's record as governor of the Federal Reserve (2002-2005), we see that he voted consistently in line with Chairman Greenspan's decisions on the fed funds rate. The Fed policy was one of unanimous support for aggressive rate cuts in response to a bear market in stocks and serious risks to economic growth and Bernanke's support for this policy was not surprising.

To see what the real Bernanke is all about, it is interesting to look at his 17-year tenure at Princeton. This may give us a preview of his thought process and decision making.

In "Monetary Policy in a Data Rich Environment," written in 2000, Bernanke argues that a richer information set into Fed analysis would improve the forecasting ability of macroeconomic time series, such as inflation.

In "Is Growth Exogenous?," written in 2001, Bernanke argues that there is strong statistical evidence against the basic Solow prediction (1956), in particular that a country's rate of investment in physical capital strongly correlated with long-run growth rate of output per worker and that rates of human capital accumulation and population growth are correlated with rate of economic growth.

In "Should Central Bankers respond to Movements in Asset Prices," from 2001, Bernanke argues for inflation targeting as an anchor for monetary policy. Therefore "once the predictive content of asset prices for inflation has been accounted for, there should be no additional response of monetary policy to asset-price fluctuations." Aggressive inflation targeting policy substantially stabilizes output and inflation in which a bubble develops and collapses.

What does it all mean?

Bernanke is likely to use a lot more economic data to determine Fed policy.

Under Greenspan, market players have been focusing on a relatively small number of economic indicators (basically the ones that the Fed has been using until now). These include the consumer price index, the producer price index, consumer confidence figures from the University of Michigan survey, etc. As Bernanke is in favor of using increased data sources for his monetary policy, the existing number of indicators will cause less market fluctuation as players will be basing their actions on much broader statistics.

Bernanke is pro-growth and believes in the active role of policy makers to stimulate growth. He doesn't believe growth is independent from macro environment and therefore may promote higher savings.

Bernanke is likely to take a hands-off approach towards asset bubbles other than setting a clear inflation target.

Lastly, it's worth noting that Wayne Angel, a former Fed governor voiced the belief of some market participants that the rate hike cycle will end when Greenspan retires. This would leave a clean slate for the incoming chairman coinciding with belief that a neutral fed funds rate hovers around 4% -- definitely bullish for market. Is VIX once more a leading indicator?

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.